Tuesday, June 14, 2016

Back in May—that’s less than two months ago—the Chief Marketing Officer of Mattress Firm (ticker: MFRM;
Tangible Book Value Negative $30.32
Per Share if our Bloomberg is correct)—was asked how business had started the
new year.

“It continues to
be a bit choppy…” he began—choppy
being one of those euphemisms Wall Street hates to hear—before adding, in the
true nature of a marketing guy, “…but we’re SUPER optimistic that we’re coming
up on summer selling season, Memorial Day...”

Sure enough, Memorial
Day did come—even if Mattress Firm appeared to begin the Memorial Day sales event
a week or two before the actual weekend—giving the CEO something positive to
talk about on the ensuing earnings call, when some of the more important
numbers were otherwise going the wrong way.

Specifically,
while MFRM showed 49% revenue growth in the first quarter, it was thanks mainly
to the acquisition of Sleepy’s and other mattress retailers the previous twelve
months.What analysts call “organic” growth was
somewhat less than 49%.

Like, 5,000 basis
points less.

Comp-store sales were
down 1.1% in the quarter (despite a boost from the inclusion of e-commerce
sales from the recently acquired 1,000-store Sleepy’s chain in those “comp-store
sales,” for some weird reason).

For a clearer
picture of the sales trend at what management itself likes to call “the first truly
border-to-border, coast-to-coast multi-brand mattress retailer,” it’s worth
noting that comp-store transactions—i.e.
stripping out the effect of sales mix—were down 0.9%.

That decline in comp-store
transactions at MFRM was not, however, a new phenomenon: MFRM has reported
declining comp-store units in each of the last five quarters (except for one
that was termed “roughly flat”).

The seemingly
innocuous 0.9% comp-unit decline in the most recent quarter looks a little less
innocuous when you consider it was up against a seemingly easy-to-beat 6.4%
unit decline in the same quarter last year.

As usual with
MFRM, however, things got better after the quarter ended, according to management on the
call: “Since Memorial Day our trends have been positive and in line with our revised
same-store sales guidance,” they said.

We’ve heard that
kind of “things got better this week” from companies reporting otherwise dour
news many times…in fact, we heard it from MFRM last year, when it reported that
negative 6.4% unit comp quarter: “However, late in the quarter we implemented
certain initiatives to drive units and we had subsequently seen positive
results.”

Prosperity at
Mattress Firm is always just around the corner.

Unfortunately,
just around that corner is a new competitor: the internet.

Specifically, what
are termed “Bed-in-a-Box” competitors (Tuft & Needle, Casper et al) that sell
mattresses rolled up in boxes delivered straight to your door by UPS and
therefore have no need for 3,500 stores like MFRM, or commissioned sales employees
or delivery trucks.

Indeed, according
to figures disclosed at a Furniture Today conference in May, the “Bed-in-a-Box”
industry—and full disclosure, your editor is a happy repeat Casper customer—is
running at a $900 million sales rate right now, from a standing start 4 years
ago.

While $900 million
might not sound like much in an industry reported to be worth $7 billion in
total (mattresses, not all bedding-related products), it would be the
equivalent of about 700 Mattress Firm stores by our math, or about 20% of those
“boarder-to-boarder, coast-to-coast” stores.

Is it any wonder
MFRM comp-store transactions have been flat-lining lately?

And while MFRM
would probably note that many of the bed-in-a-box vendors are establishing
show-rooms in major cities like Manhattan, we’d bet money that they won’t open
anything close to 3,500 stores when it’s all over.

Why bother?They’re already “boarder-to-boarder, coast-to-coast”
mattress retailers, in the sense that they can ship anywhere a UPS truck can
go, without the fixed cost structure.

All this makes
last night’s news that MFRM had disclosed a “material weakness” in its
just-filed 10Q involving “controls relating to accounting for significant
transactions” even more interesting than the usual “material weakness”
disclosure in your average 10Q:

"Specifically,
we did not design and maintain effective controls related to the recording of
the expense for the flow through of the inventory step up fair value adjustment
in the Sleepy's acquisition. We believe the financial statements included herein
properly reflect the correct amount and proper classification of the flow
through of the Sleepy's inventory step-up adjustment….”

You
might think that a company with $1.1 million of cash and $1.6 billion of total
intangible assets on its balance sheet (thanks to its “coast-to-coast” rollup
of mattress retailers) against $1.45 billion of debt, negative $55.4 million of
retained earnings and $477.4 million of total shareholder equity would have been on
those issues before they cropped up, but apparently not.

Meanwhile, and unfortunately for MFRM, the
Caspers of the world are not sitting still, and watching a reported $900
million worth of mattresses get siphoned off to direct-to-consumer competitors
is exactly the thing Mattress Firm doesn’t need at this moment.

The company spent
years steadily snapping up new geographies as part of its grand plan—Mattress
Giant, Sleep Experts, Mattress Liquidators, Best Mattress, Sleep Train and,
finally, Sleepy’s—at the very moment clever Millennials were figuring out how to
design, manufacture and ship a mattress in a box so that they and their friends
didn’t have to deal with the process of schlepping down to one of those stores
Mattress Firm has been accumulating.

So when we hear
the word “choppy” to describe the sales environment—as we did in May from MFRM’s
own marketing man—our ears perk up.

“Choppy” is one of
those Wall Street euphemisms that can often mean a whole lot more than it looks
on paper.

It’s right up
there with analysts who are “tweaking our estimates lower” (i.e. slashing them)
and sales that have “come in a bit light” (i.e. not even close to plan).

Or, our favorite,
management that is “laser-focused” on the company’s problems (i.e. playing
solitaire on their iPhones).

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